Wednesday, June 2, 2010 1:56 PM EDT
Positive Link Between Oil and Stock Prices Likely To Continue
By Palash R. Ghosh
Since the historic collapse of Lehman Brothers helped precipitate the global economic crisis in autumn 2008, we have observed an unusually strong correlation between oil prices and U.S stock prices - in stark defiance of their traditional inverse relationship.
Normally, higher energy prices hurt to most stocks because they increase the operating costs of corporations and signal rising core inflation.
But we have found ourselves in anything but "normal" times.
Oil seems to be trading primarily on investors' expectations about global economic strength and energy demand - thus, weakening crude prices indicate greater pessimism about the outlook for global economies. Over the past month, an ever-worsening debt crisis in Europe has exacerbated these fears, pushing up the US dollar against the euro, further tightening the positive correlation between crude and equities.
And this link is likely to continue, at least for the short term.
The one thing that might break the link, that is, serve as a catalyst for a near-term spike in oil prices, might be the potential repercussions from an act of God - the devastating oil spill in the Gulf Coast by British Petroleum.
"If this spill leads President Obama to declare a temporary moratorium on offshore drilling, it would likely push up the price of oil," said Steve Stahler, president of The Stahler Group, an investment advisory firm in Baton Rouge, La.
In that event, oil could rally and drive stocks further downward - thereby, ironically, restoring their normal inverse relationship.
Stahler believes a shut-down in offshore drilling is probably unlikely, but could be devastating for the US oil industry should it come to pass.
"The BP spill itself really has had no negative impact on US and global stock markets, given how so many other woes, like sovereign debt, these markets already face," he said. "But a shutdown in drilling could have a harmful impact on oil companies and their growth prospects. It would be like closing down all McDonald's restaurants because someone spilled some hot coffee on their laps somewhere."
Meanwhile, oil and stocks look to move in tandem, especially as pessimism about the sustainability of a global economic recovery remain high. A continued recovery in the US economy, however, might place a floor on crude prices, especially if Friday's jobs picture brightens.
Tommy Williams, president of Williams Financial Advisors in Shreveport, La., cites that for the past year and a half, perhaps longer, crude oil has traded more on psychology and trading issues, rather than on cold hard fundamentals - and this represents the essential conundrum in assessing the energy markets.
"The uncertainties have really not lifted since Lehman imploded and this has caused havoc in both equity and commodity markets," he noted. "We haven't seen a return to equilibrium where assets move according to fundamentals; there are now simply too many other variables that are impacting asset prices."
Keep in mind, the price of crude remains substantially lower than the all-time peak it ascended in July 2008 (a few months before Lehman).
"Technically, I think crude oil prices are suffering from the bubble that they were in during the first half of 2008, and the subsequent plunge in prices," said Mark Arbeter, chief technical analyst at S&P. "There has been tremendous damage to the chart, and it may take years of sideways trading to repair this damage."
Indeed, the behavior of oil seems no different than what the NASDAQ has been going through since 2003. Arbeter expects crude oil to trade "in a very wide range for many more years, never getting close to the levels we saw in 2008 for an extended period."